Round Number Magnet Strangle

The power of round numbers does not seem to receive a lot of play in investment circles. Sure, there is the psychological significance of an index or a stock crossing above or below a round number, but I am surprised that nobody ever talks about how to trade these.

Rather than look as round numbers as potential areas of enhanced support or resistance, I like to think of them has having a strong attractive power, almost as if they are large magnets. In some indices and stocks, prices tend to linger near round numbers for longer periods than a random distribution would suggest.

One way to take advantage of the attractive tendencies of round numbers is to sell options at or near that strike. Straddles, strangles, butterflies and iron condors would certainly be appropriate choices, but I have personal preference for strangles, with their wide maximum profit zone and simple construction/position management.

These ‘magnet straddle’ plays can utilize options of any duration, but maximum time decay (theta) is achieved in the last few weeks prior to expiration. In the graphic below, which is courtesy of optionsXpress, I show that anyone interested in selling an 890-910 strangle on the SPX can make a profit if the index manages to stay in a 40 point zone (880-920) during the last three days prior to expiration.

I feel obliged to mention that conventional wisdom says expiration week is too fraught with short-term uncertainty and gamma risk to be traded profitably on a consistent basis, yet I still think there are a number of opportunities where probabilities favor the experienced options trader.

Finally, if this trade sounds somewhat familiar, readers may be interested in checking out a similar straddle trade in Is the SPX Going to Stick Close to 900? from last December. With a VIX in the upper 50s when the original trade was discussed, the profit zone of 840-960 makes it look like a slam dunk winner by current volatility standards.

[graphic: optionsXpress]